September 16, 2021
In a nutshell: Oil is a popular commodity, otherwise known as an economic resource. Oil prices dropped dramatically after lockdown measurements and fears of inflation and supply shortage arose. However, the fall didn’t last too long as the government came to the rescue. Commodities are rising as a result of injecting stimulus into the economy and record-low interest rates.
The COVID-19 pandemic caused headaches for crypto, stock, and real estate investors in March 2020. However, they weren’t the only investors taking Tylenol. However, one of the most famous events that unfolded during the COVID crash happened seemingly outside of the view of most retail investors.
The collapse of oil prices came after stay-at-home orders left producers and financial institutions holding onto way too many barrels of the commodity. The fire sale got so bad that oil actually went negative. And just as soon as it went negative, it began to climb once again.
Oil is a commodity, which is a word used to describe economic resources. In many cases, they are raw materials that have significant trading activity. They include energy commodities such as oil, agricultural products like corn, and precious metals like gold. But commodities trading is not exactly like buying a stock. It’s something completely different and complicated to most retail investors, which is why most investors don’t have any exposure to commodities at all!
But over a year after the COVID crash, commodities such as oil have experienced significant gains. Some have even gone to all-time highs during the pandemic. So what gives? Why are commodities rising, and how can you invest in them?
Why Commodities Are Rising
In March 2020, as the COVID-19 pandemic permeated outward, the global economy came to a halt. Companies were forced to shutter operations, service businesses had to close, and millions were ordered to stay at home.
Commodities such as oil and corn shared the downward spiral in asset prices. However, as we all know by now, that spiral was short-lived. By April 2020, the COVID-19 crash had mostly concluded. The government began to shore up markets by injecting stimulus into the economy. With the help of trillions of newly-printed bills (namely stimulus) and record-low interest rates (namely the ability to easily borrow money), investors began to pile money into all kinds of stuff.
With this framing, we can start to understand the two reasons why commodities (and other “real assets”) rose so much. Those two reasons are fears about inflation and supply shortages. However, before we dive deeper, it might be wise to think about money (currency) as an asset all its own.
Fears About Inflation
The first reason, fears about inflation, were prompted by the “easy access to money.” Most people with a very basic understanding of economics understand that the more of something that there is, the less scarce it is.
Since money itself is an asset, when there is less of it, it tends to be less scarce. And with that lesser scarcity comes lower values. In short: the dollar lost value against other assets. And in the case of “real assets” where supply cannot be quickly adjusted to accommodate demand (such as real estate and commodities), the dollar really lost its edge.
Because the concept of scarcity and supply-demand relationships is so elementary, you can start to understand why investing in anything was perceived as beneficial. For seasoned investors, investing directly in real assets comes with its own benefits.
The second reason, supply shortages, can mainly be attributed to the disruption of global supply chains by the COVID-19 pandemic. It’s not easy to suddenly stop the production or processing of goods, then immediately revert back to business as usual. In the case of the crash of oil, oil prices recovered just as quickly as they crashed into negative territory. That’s because, as you know now, demand eventually became commensurate with supply again as the pandemic waned.
These supply shortages were not just exclusive to oil. They cropped up in nearly every major market. Commodities such as copper, grains, and lumber all rose to highs when shortages wreaked havoc on the market. And where investors perceive shortages or “value deficits”, there is yield to be had. And since real assets are so limited and essential to our economy, investors knew that there was money to be had in these markets.
However, the supply shortages might not necessarily be everlasting. One commodities ETF holding a basket of commodities contracts is up just 4.9% over the last five years. That’s because it takes time for markets to meet sudden demand, but once innovation or competition takes hold, prices seldom rise any more than base inflation (in the U.S, about 2-3%).
Should I invest in commodities?
So that might have you wondering: is investing in commodities a good idea? Well, maybe it was back in April 2020, but now? It’s hard to tell. As of June 16, 2021, the Dow Jones Commodity Index is up 53.7% YoY. These gains considered, the 10-year return of the Dow Jones Commodity Index is 0.79%. Certain commodities are likely to inherit growth as a result of supply shortages or artificial scarcity. However, not all commodities will.
Take oil, for example. Oil is a commodity which is temperamentally affected by organizations like OPEC+, which help decide how much oil will be admitted to the market. Throughout June and July 2021, OPEC+ countries have disputed how much crude they’d like to have admitted to the market. Depending on if they decide to raise the supply cap, that could have a significant impact on the price of global oil.
On the other hand, some commodities such as lumber have bounced violently off their tops. Lumber nearly quadrupled from March 2020 to its peak in May 2021. It has now erased all of its 2021 gains and is trading back into its 2020 price territory. That’s a significant collapse in price.
So the answer is: it’s complicated. If you were interested in getting familiar with the commodities futures market and facing its many nuances? Maybe it would be worth it. But buying a basket would certainly necessitate buying an ETF tracking one or many commodities, which could render varied results. You’d ultimately have to know a thing or two about individual commodities or bet your cash on the performance of many commodities which are influenced by one or many factors.
Ultimately, you could decide to invest exclusively in commodities such as oil through ETFs like $OILK. You could also invest in gold using $GLD, silver using $SLV, and sugar using $CANE. Alternatively, you could put chips on a few different options by buying a basket. Options include buying a variety of agricultural commodities through $TAGS or $DBA, precious metals through $GLTR, or a basket or many commodities through $BCI or $COM.
Naturally, there are many other alternatives, so let these many options act as a foundation for you to spring forward from. Each fund will have its own way of approaching the commodities market, carrying varied weightings of certain assets. That said, it’s wise to read up on the commodities or assets you’re interested in. You can check out the biggest commodity ETFs on etfdb.com.
It’s true that the gains in certain “genres” of commodities are relatively paltry compared to major equity indexes or bonds. But if you see long-term appreciation opportunities, or a swing trade opportunity in one or more commodities, then commodities might have a place in your portfolio.